Mean-Variance Analysis

AAA

DEFINITION of 'Mean-Variance Analysis'

The process of weighing risk (variance) against expected return. By looking at the expected return and variance of an asset, investors attempt to make more efficient investment choices- seeking the lowest variance for a given expected return, or seeking the highest expected return for a given variance level.

Mean variance analysis is a component of modern portfolio theory, which assumes investors make rational decisions, and that for increased risk they expect a higher return. 

INVESTOPEDIA EXPLAINS 'Mean-Variance Analysis'

There are two major factors in mean variance analysis: variance and expected return. 

  • Variance represents how spread out the data set numbers are, such as the variability in daily or weekly returns of an individual security.
  • The expected return is a subjective probability assessment on the return of the stock. 

If two investments have the same expected return, but one has a lower variance, the one with the lower variance is the better choice.

By combining stocks with different variances and expected returns in a portfolio (diversification), the variance and expected return of the portfolio can be altered as the price moves of one stock may be offset by the price moves of another in the portfolio. 

RELATED TERMS
  1. Sharpe Ratio

    A ratio developed by Nobel laureate William F. Sharpe to measure ...
  2. Exchange-Traded Fund (ETF)

    A security that tracks an index, a commodity or a basket of assets ...
  3. Smart Beta

    Investment strategies that emphasize the use of alternative weighting ...
  4. Discretionary Investment Management

    A form of investment management in which buy and sell decisions ...
  5. Account Minimum

    The minimum balance required to be maintained in an investment ...
  6. Capital Growth

    The increase in value of an asset or investment over time. It ...
RELATED FAQS
  1. How much of a diversified portfolio should be invested in the electronics sector?

    The electronics sector tracks closely with the broader market, making it a cyclical sector with average volatility. Electronics ... Read Full Answer >>
  2. What are some common questions an interviewer may ask during an interview for a position ...

    When interviewing for a job at an investment bank, a candidate is likely to answer questions about his career and education ... Read Full Answer >>
  3. What is the difference between a simple random sample and a stratified random sample?

    Simple random samples and stratified random samples differ in how the sample is drawn from the overall population of data. ... Read Full Answer >>
  4. What are the advantages and disadvantages of using systematic sampling?

    As a statistical sampling method, systematic sampling is simpler and more straightforward than random sampling. It can also ... Read Full Answer >>
  5. What is the difference between the standard error of means and standard deviation?

    The standard deviation, or SD, measures the amount of variability or dispersion for a subject set of data from the mean, ... Read Full Answer >>
  6. How does market risk differ from specific risk?

    Market risk and specific risk are two different forms of risk that affect assets. All investment assets can be separated ... Read Full Answer >>
Related Articles
  1. Investing Basics

    Modern Portfolio Theory vs. Behavioral Finance

    Modern portfolio theory and behavioral finance represent differing schools of thought that attempt to explain investor behavior. Perhaps the easiest way to think about their arguments and positions ...
  2. Fundamental Analysis

    Calculating Covariance For Stocks

    Learn how to figure out how two stocks might move together in the future by calculating covariance.
  3. Investing Basics

    Diversification: Protecting Portfolios From Mass Destruction

    This investing strategy retains its charm as a protection against random events in the market.
  4. Investing Basics

    Introduction To Investment Diversification

    Reducing risk and increasing returns in your portfolio is all about finding the right balance.
  5. Personal Finance

    Diversification: It's All About (Asset) Class

    Frustrated stock pickers rejoice - asset class selection is simpler and safer.
  6. Active Trading

    Modern Portfolio Theory: Why It's Still Hip

    See why investors today still follow this old set of principles that reduce risk and increase returns through diversification.
  7. Bonds & Fixed Income

    Does International Investing Really Offer Diversification?

    Historically, international investing has worked out well for investors, but this may no longer be the case.
  8. Fundamental Analysis

    What is Quantitative Analysis?

    Quantitative analysis refers to the use of mathematical computations to analyze markets and investments.
  9. Fundamental Analysis

    Understanding the Simple Random Sample

    A simple random sample is a subset of a statistical population in which each member of the subset has an equal probability of being chosen.
  10. Economics

    What is Systematic Sampling?

    Systematic sampling is similar to random sampling, but it uses a pattern for the selection of the sample.

You May Also Like

Hot Definitions
  1. Expected Return

    The amount one would anticipate receiving on an investment that has various known or expected rates of return. For example, ...
  2. Carrying Value

    An accounting measure of value, where the value of an asset or a company is based on the figures in the company's balance ...
  3. Capital Account

    A national account that shows the net change in asset ownership for a nation. The capital account is the net result of public ...
  4. Brand Equity

    The value premium that a company realizes from a product with a recognizable name as compared to its generic equivalent. ...
  5. Adverse Selection

    1. The tendency of those in dangerous jobs or high risk lifestyles to get life insurance. 2. A situation where sellers have ...
Trading Center